Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Food & Life Companies Ltd. (TSE:3563) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Food & Life Companies
What Is Food & Life Companies's Debt?
You can click the graphic below for the historical numbers, but it shows that Food & Life Companies had JPÂ¥84.5b of debt in September 2024, down from JPÂ¥89.0b, one year before. However, it also had JPÂ¥48.7b in cash, and so its net debt is JPÂ¥35.9b.
How Healthy Is Food & Life Companies' Balance Sheet?
We can see from the most recent balance sheet that Food & Life Companies had liabilities of JPÂ¥80.8b falling due within a year, and liabilities of JPÂ¥206.5b due beyond that. Offsetting this, it had JPÂ¥48.7b in cash and JPÂ¥13.9b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JPÂ¥224.7b.
Food & Life Companies has a market capitalization of JPÂ¥401.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Food & Life Companies has a low net debt to EBITDA ratio of only 0.66. And its EBIT easily covers its interest expense, being 13.5 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Food & Life Companies grew its EBIT by 47% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Food & Life Companies can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Food & Life Companies actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Our View
The good news is that Food & Life Companies's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. Looking at the bigger picture, we think Food & Life Companies's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Food & Life Companies you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
About TSE:3563
Solid track record and good value.
